The role of independent directors in a successful family business

By F. Douglas Raymond, Laura B. Fix

A thriving family business generally owes its success to family members who have devoted themselves to the enterprise. No one else has as much invested, either financially or psychologically, in the long-term success of the business as they have. So why should the family consider bringing in outsiders to serve as directors? After all, the family understands the business and the dynamics among family members (and family branches) better than anyone else could.

Nonetheless, for many companies there can be significant advantages to adding independent directors (non-family members with no connection to the company) to the board. These directors can provide valuable perspectives on challenges facing the company and the family.

A board’s core functions are often described as identifying the company’s strategy, hiring (and, when necessary, firing) the chief executive officer and stepping up to help manage the company during important transitions and times of crisis. In addition to providing insights on day-to-day operational issues, an independent director can fulfill these core functions, in some ways, more effectively than a family member.

Diversity of perspective and expertise

Many families have an established hierarchy, often with a dominant patriarch or matriarch. This is true of highly
functional as well as dysfunctional families. In family businesses, this hierarchy is almost inevitably carried into the boardroom. Family members serving on boards often find it difficult to critique the plans of the dominant family member, especially if he or she is the founder or has been a crucial driver of the business. In addition, the patriarch or matriarch is often dismissive of the concerns raised by younger relatives. This is problematic from a corporate governance perspective. Good corporate governance depends on free and open discussion among directors, including candid discussions of different perspectives.

In recent years, there has been a strong effort by institutional investors and others to separate the roles of the chairman and the CEO. This separation of roles is designed to level the playing field and allow for more robust boardroom discussions by lessening the dominance of a single director and creating, in a non-executive chairman
or lead director, a countervailing influence. In a family business, independent directors can serve a similar function and provide a counterpoint to the patriarch or matriarch. Having an independent director who is able to speak frankly, even in an uncomfortable circumstance, can also give other family members space in which they, too, may be able to express differing perspectives. Adding an independent voice can transform the boardroom from a primarily family dynamic to a more professional atmosphere where discussion is not cut off merely because “we’ve always done it that way,” or because “that was your mother’s favorite [whatever].”

Moreover, studies have conclusively demonstrated that the quality of a board’s deliberations can be meaningfully improved if directors with different perspectives are participating. Diversity of perspective helps the board consider the challenges a company is facing from different angles, better identify unexpected risks and complications of proposed actions, and come up with creative solutions. In many family businesses, family members have similar backgrounds. Particularly in “bet the company” scenarios, family companies benefit from the different experiences, backgrounds and perspectives that independent directors can bring.

Most public companies, and many others as well, have adapted skills matrices where they identify the qualities and characteristics they seek in their directors. These address diversity of expertise as well as diversity in terms
of gender, ethnicity and sexual orientation. Over time, the skills required of directors The role of independent directors in a successful family business will vary, and it is unlikely the family will have a suitable expert waiting in the wings for every situation. For many companies, this need for different backgrounds, whether to capitalize on opportunities or navigate a perilous situation, has led to bringing on an outside director.

Conflict and changes are inevitable

The best time for an independent director to join the board of a family business is when the company is not facing
any significant challenges. This gives the director time to learn the business and gain the trust and confidence of the other board members and family constituencies without having to simultaneously address an urgent crisis. Developing a deep understanding of the business and the family and building trust are very important if one day trouble arrives.

When disputes and conflicts arise, they are often colored by the established power dynamic among the family members, which can affect the quality of the board’s decision-making process. As highlighted by the cliché “family firms fail for family reasons,” one of the unique challenges faced by family companies is the potential for disruptive conflict among family members, sometimes for reasons not related to the business. A 2017 survey of U.S. family businesses by PricewaterhouseCoopers (PwC) found nearly two-thirds have multiple owners (“The missing middle: Bridging the gap in U.S. family firms,” PwC, 2017). This can, and often does, lead to conflicts among family members, particularly if only some of the owners are active in the business. Even if a family director’s views are sound, others may take opposing sides based on family or historical relationships
rather than business reasons or the best interests of the company and all the owners.

If conflicts arise, the business needs respected voices who can offer a perspective not colored by familial pressures and who owe their allegiance and fiduciary duties to the entire business and all its stockholders — not just one family branch. And perhaps most important, the presence of an outside director in the boardroom often helps the family directors to remain professional and focused, much the way having guests over for Thanksgiving dinner puts everyone on better behavior.

Although change is inevitable, transitions can cause friction and create strife among family members. Having a person in the boardroom who knows the business well and has managed other companies during similar transitions can be a major asset for a family business.

Management succession and the transfer of responsibility between generations is one frequently difficult transition. According to the 2017 PwC family business survey, less than a quarter of family companies have succession plans in place. The subjects of retirement and transition can be difficult to raise, much less press, with parents, aunts and uncles. An independent director is able to raise these issues diplomatically, without offending the family hierarchy, and can encourage reluctant elders to buy into succession planning. Further, an experienced independent director can help identify situations where a family member may be underperforming, or positions where an unexpected departure would cause turmoil in the business, and help define what competencies are necessary for a successor in that role.

In a family business, several family members may have built careers at the company. This can be particularly
tricky if different constituencies have differing expectations about who should take over leadership roles. In these situations, an independent director can influence the decision because he or she is unaffected by family history or power struggles. In companies where there has been some succession planning, an independent director can drive consensus to formalize the plan. This will help ensure the family and management are working toward the same goal. When it comes time to implement a succession plan, the new leaders may also find that having the backing of an independent director gives them legitimacy in the eyes of company employees.

While many families want family members to run their business, that is not always the best choice. It can be hard for family members to offer an accurate evaluation of their cousin, daughter or nephew, and even harder to tell the family that an “heir apparent” may not be best suited to manage the company. In the 2017 PwC survey, only 21% of respondents said they believe they do a good job of appraising next-generation family members against non-family members for promotions. An independent director is frequently in a better position to objectively evaluate family members for management positions, and can consider whether it is better for the business to bring in a non-family manager.

In addition to being able to help identify when outside talent should be tapped, independent directors make it easier for a family company to attract non-family managers. When a family business actively involves independent directors, others see it as evidence that the family business is focused on professionalization. The non-family recruit can be more confident that the family members are willing to welcome non-family members into the company, and can see that the family is putting its desire to grow the company ahead of its desire to micromanage the business.

In each of these moments of family conflict and periods of change, independent directors can manage the conflict or smooth the transition by keeping all parties focused on analyzing the best business outcome. During periods of change, family members who have dedicated years of their lives to the family company may experience difficulty
adjusting to the changes. A trusted independent director can be a valuable asset as a calming voice of reason in such circumstances. FB

F. Douglas Raymond is a partner and Laura B. Fix is an associate at Drinker Biddle & Reath LLP in Philadelphia.

July/August 2018

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